English for the Financial Sector: Lesson 16: Monetary policy - 17

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Kate Barker: At the Bank of England, in common with most central banks round the world now, when we look at monetary policy, it involves changing interest rates. The aim of monetary policy is to keep inflation low and stable. When you are setting interest rates, what you are trying to do is to keep demand in the economy, what people consume, how much they invest, in line with the long-term ability of an economy to supply goods and services through labour, through people employed, and through the capital employed, machinery, plant and equipment in the economy. When interest rates rise, this will mean that individuals will tend to save more and consume less. Also for companies, investment decisions are more expensive and that means that demand will tend to be reduced. When interest rates are cut, the opposite happens – people will spend rather than save and companies have more of an incentive to invest, and that means that the level of demand rises. And it’s by trying to set demand, to keep demand in line with supply in future, so that the central bank is always looking ahead. When the central bank sets the base rate for lending to commercial banks, it affects the whole structure of interest rates in a country. For example, in the United Kingdom one of the things it affects very quickly is the rate at which the banks and other organizations lend to households for their mortgages, but of course it will also affect the rates at which companies borrow. Of course that just means that the central bank controls the short-term interest rate. What happens to other interest rates, one-year, five-year, ten-year interest rates, can be quite different.